Discriminating monopoly, first-degree price discrimination and whether it is desirable

Discriminating monopoly

A discriminating monopoly is a monopolist that charges different prices to different buyers (or for different units) of the same product, where the price differences are not due to differences in the cost of supplying them. For discrimination between groups (third degree) to be possible and profitable:

1. Monopoly power: the seller must be able to set price; competitive firms cannot discriminate.
2. Separation of markets: buyers can be divided into groups by age, place, time, income or use, and the seller can tell which group a buyer belongs to.
3. No resale: buyers charged the low price must not be able to resell to those charged the high price (services such as medical consultations and travel cannot be resold).
4. Different elasticities of demand: for profit, the groups must differ in how strongly they respond to price; the higher price is charged where demand is less elastic.

First-degree discrimination needs instead that the seller knows each buyer's reservation price and can stop resale.

First-degree price discrimination

First-degree (perfect) price discrimination is pricing unit by unit and buyer by buyer. The seller is assumed to know every buyer's reservation price, the most that buyer would give for a unit, and it sets the price of each unit at exactly that reservation price. A buyer then pays for every unit just what the unit is worth to him and gains nothing over and above it, so no consumer surplus is left to anyone.

Diagram. Quantity on the horizontal axis, price on the vertical axis; a downward-sloping demand curve D and, for simplicity, a horizontal marginal cost curve MC (constant marginal cost, equal to average cost).

• Because every unit is sold at its own reservation price, selling one more unit does not lower the price of earlier units. The demand curve itself becomes the marginal revenue curve.
• The monopolist therefore expands output to OQ*, where the demand curve meets MC, the same output a competitive market would produce.
• The whole area under the demand curve above MC, up to OQ*, is captured as the monopolist's profit. With constant marginal cost, this area is exactly the consumer surplus buyers would have enjoyed in a competitive market (where the price would equal MC); with rising marginal cost it is the whole surplus, consumers' and producers' together, at the efficient output.

Effects. Output is the efficient level (price of the last unit = MC), so there is no deadweight loss; but all the gains from trade go to the seller. In practice perfect discrimination is rare; near examples are a lawyer or doctor setting fees case by case after judging each client's means, or bargaining in a bazaar.

Is price discrimination desirable?

Arguments for

1. Higher output and wider access: discrimination can let the firm serve buyers who would be priced out under a single price (concessional fares for students and senior citizens, lower prices for medicines in poorer markets).
2. Viability of services: some services cover their costs only if the firm can charge different groups differently, such as railways with different classes or a rural clinic charging well-off patients more.
3. Efficiency in the first-degree case: output reaches the competitive level and there is no deadweight loss.
4. Fairness in some cases: charging the rich more and the poor less can be equitable.

Arguments against

1. Transfer of surplus: consumers lose surplus to the monopolist, in full under first-degree discrimination.
2. Inequity between buyers: buyers paying more for the same product may see it as unfair, especially when the distinction is arbitrary.
3. Output may not rise: under third-degree discrimination total output may stay the same or fall, and welfare may then be lower than under a single price.
4. Costs of separating markets and preventing resale use up resources.

Conclusion

Discriminating monopoly charges different prices for the same product where markets can be separated and elasticities differ. First-degree discrimination takes all consumer surplus but produces the efficient output. Whether discrimination is desirable depends on its effect on total output and on who pays more: it is defensible when it extends supply to buyers who would otherwise be left out or keeps an essential service running, and objectionable when it merely transfers surplus from consumers to the seller.